Most of you who have taken business loans or merchant cash advances are familiar with the UCC-1 financing statement filed against your business. It’s one of the most common questions that we see: How long does a UCC last? Is there a way that it can go away? The short answer is five years unless the creditor has filed a continuation statement. There is, however, a wrinkle in that story if the business has fallen into bankruptcy.
A Financing Statement Is Generally Good for Five Years
A UCC-1 financing statement is a public record that tells the world a certain creditor has a security interest in the business’s assets. How long does it stay in effect? A financing statement is generally good for five years (UCC 9-515). To keep it alive, the creditor needs to file a continuation statement. If the creditor doesn’t, the financing statement lapses on its expiration date. The initial filing alone doesn’t give an indefinite lien; the creditor has to take an extra step to keep it alive.
Once a financing statement lapses, the security interest becomes unperfected, and under section 9-322(a)(2) a perfected security interest has priority over a conflicting unperfected one. That means a secured creditor who doesn’t file its continuation statement loses its place in line. It’s a risk that only really matters when you have more than one secured creditor looking at the same assets. If a lender wants to retain its lead position it has to be vigilant and make sure it files a continuation statement. Put simply, the party that keeps up with its paperwork comes out on top.
Freeze Rule
If the business is in bankruptcy, this gets a different answer. That is because of what’s called the freeze rule. At the moment the bankruptcy petition is filed, the priority of each security interest is frozen. It stays that way for the entire case. The Supreme Court has recognized this rule at least as far back as 1931 (Isaacs v. Hobbs Tie & Timber Co.). The law was, and is, that valid liens when bankruptcy begins are preserved.
This happens in real life. Take In re Essex Construction, LLC, decided by the Bankruptcy Court for the District of Maryland in 2018. Essex filed for chapter 11 in 2016. On that date, Industrial Bank and Firstrust Bank both had perfected security interests in Essex’s assets. Industrial’s UCC-1 had been filed back in 2012, making it senior, and Firstrust’s in 2014. Fast forward to 2017, and the case was still in chapter 11. But in the meantime, Industrial’s financing statement lapsed, because five years had passed.
Neither bank disputed that Industrial was senior on the petition date. The battle centered on the legal effect of that lapse. Firstrust says Article 9 dictates that its security interest takes priority over Industrial’s from that moment, and bankruptcy shouldn’t alter that result. Industrial answered that the bankruptcy freeze rule means the filing freezes the parties’ relative priorities as of the petition date, and they can’t move around afterward.
Firstrust also cited history: an old version of the UCC said that when a security interest is perfected by filing, and then bankruptcy (or some other insolvency) proceedings start, the security interest stays perfected until they end. The language was removed in today’s UCC, Firstrust argued, and this shows the drafters intended to abolish the “freeze rule.” The court said that argument is not supported by the official comments to Section 9-515, which said the drafters did not intend to abolish the freeze rule. The official comments leave it to courts to decide what effect an Article 9 filing’s lapse has on priority, based on federal bankruptcy law.
A couple of old cases demonstrate this rule, and it’s important to know what they say. In Halmar Distributors the debtor had moved its inventory to a new location in Massachusetts. The senior secured creditor had filed a financing statement in New York. The junior creditor filed in both New York and Massachusetts. Under the UCC, the senior creditor had to file in Massachusetts within four months, but it didn’t. Nonetheless, the court said the senior creditor remained senior. Its priority had frozen when the debtor filed for bankruptcy, and the lapse came later. In Chaseley’s Foods, the secured creditor failed to file a continuation statement during a bankruptcy. The court ruled the creditor remained secured anyway. It also said bankruptcy keeps the creditor’s priority whether or not a UCC provision says so. A lapse changes nothing.
Essex came out the same way. Before the bankruptcy, Industrial was ahead of Firstrust. On the day of the filing, Industrial was ahead. But when Industrial’s financing statement lapsed after the filing, nothing changed. Under the UCC alone, Industrial would have lost priority. But the “freeze rule” kept it standing. The drafters of the UCC affirmed that result in their comments to Article 9. So the bottom line is: If you are a senior secured creditor in a bankruptcy, you do not need to file a continuation statement to maintain priority.
What does this mean for you? Let’s say you have a bank loan, some merchant cash advances stacked on top of each other, all with liens on the same assets. Outside of bankruptcy, a creditor that neglects to continue its filing after five years can lose its spot in line to a creditor that kept its filing in the system. If you’re considering filing bankruptcy, don’t assume that a lapse after filing will reshuffle who gets paid first. The ranking is set the day you file. At Delancey Street, we’re a debt settlement company, not a law firm, so if bankruptcy is the best option, we refer you to an independent attorney. When negotiating is the better path, our senior advisors deal with the funders and lenders directly and push for less than the full balance owed.
A UCC lien doesn’t automatically stick around for life. It is good for five years, and it lapses unless the creditor files a continuation statement. In bankruptcy, though, the line freezes. If you’re the kind of person who is juggling payments to multiple lenders who all have a UCC lien, and you can’t make them, talk to us before you choose between negotiation, settlement or bankruptcy. Our initial consultation is free and confidential. If there is a more affordable alternative, or bankruptcy is the right path, you will hear that on the first phone call.
